FAMILY AND TAX: by Stephen SmithNews Weekly
Restore the family wage by simplifying the tax system
, April 13, 2013
Two changes are needed for the taxation and family benefits system to improve efficiency and achieve equity between families.
The first step is to replace the current complicated family tax benefit payment schemes with a single lump-sum payment per child.
All existing family allowances, childcare subsidies, maternity allowances and other concessions for children in the current tax-transfer system, should be replaced with a uniform, non-means-tested annual taxation concession, such as a tax credit or a cash allowance. If the payment is uniform, every family will receive the same monetary value per child.
The second step is to adopt an optional family-based taxation system. Income-splitting, as it is commonly known, involves pooling family income for taxation purposes, with each family unit submitting a single tax return.
Family-based taxation is currently allowed in numerous OECD nations: the United States, France, Germany, Belgium, Greece, Luxembourg, Portugal, Switzerland, Iceland, Ireland, Norway, Poland, Spain and the Netherlands.
The rationale in each country is the same: the household, not the individual, is the basic economic unit of society, so the family should be treated as a single unit for taxation purposes.
There are several arguments for simplifying the tax transfer system. First, the current means-tested tax transfer system, which is designed to alleviate poverty, may actually entrench poverty, particularly at low-income levels, where the system imposes large penalties for earning extra income.
Second, the current system confuses child-rearing responsibilities with welfare. A single universal payment would recognise that the difficult work undertaken by parents to rear the next generation is of great benefit to society. The value of this work does not diminish as family income increases, so neither should payments that recognise that work.
Third, the large bureaucratic structure set up to assess each family’s eligibility for tax transfers only exists because the current system is complex. The amount of Family Tax Benefit received is based on a complicated formula that takes into account both individual and family income and is difficult to calculate.
Other payments, such as childcare benefits, are even more complicated and virtually impossible for individuals to assess. This complexity creates a burden for many taxpayers, particularly those with limited English-language skills or poor numeracy. In these circumstances, the operation of government programs is anything but transparent and therefore antithetical to good governance.
Finally, and arguably most compelling of all, simplifying the tax transfer system will reduce the amount of what is known as fiscal churning, a mutually offsetting tax and expenditure flow, or in plain terms, spending tax revenues from someone to provide income and government-funded services “back” to that same person.
The main problems with churning are that it is associated with the development of a welfare mind-set that lowers self-esteem and individual responsibility and encourages political rent-seeking.
Churning also distorts economic behaviour via rules associated with both the tax and the transfer-related effects, if the net value of the transfer is zero.
Another problem with churning is it requires significant administrative support at all stages of the process, particularly ones that are intrusive and complicated, for example, those that involve means-testing of payments.
Churning, from a purely economic perspective, is undesirable because it is a deadweight loss in that the transfers destroy resources needlessly while producing nothing that citizens can use or enjoy.
The marginal social cost of transferring one extra dollar in the US system may be as high as $3.50, and there is no reason to expect that transfers in Australia will be close to cost-neutral either.
Computer-based systems can reduce the administrative cost of churning by executing simple repetitive tasks efficiently; but, unfortunately, the activities that generate the most cost in any business process are difficult to automate.
These activities include ongoing maintenance of highly complex computer systems, dispute resolution and debt recovery. Simplifying the tax transfer system will help to eliminate these inefficiencies and therefore reduce both churning and the associated cost of administration.
Simplifying transfer rules and rolling transfers, such as family tax benefits, into the taxation system will cut churn dramatically. The existing family payment system already treats the family as a single economic unit, so administering revenue on this basis will merely simplify the existing system. For example, if revenue is family-based, some existing family-based payments could in principle be abolished because they would no longer be unnecessary.
From the government’s point of view, simplifying the tax transfer system should not just be cost-neutral, but actually provide significant costs savings. The total cost of the tax transfer system, including health and education, is in excess of $250 billion per year. Eliminating even a small proportion of churn from these programs would save hundreds of millions of dollars.
Stephen Smith is a senior lecturer in the department of accounting and finance at Melbourne’s Monash University.